The Institute of Economic Affairs warns that stimulus measures could push us into recession

The Institute of Economic Affairs (IEA) has issued a warning to the Government, suggesting they maintain current plans to reduce the deficit, and resist any temptation to follow a 'Plan B'. Research published by the IEA draws on evidence from other Western governments' stimulus packages which have failed to resolve their sovereign debt crises. The report, a transcript of Professor Robert Barro's Annual Hayek Memorial Lecture at the IEA, has five key findings:

Economic output may be increased in the short term by fiscal stimulus packages, but in the longer term the effect would be negative - the third year of measures would mean substantial inflation rises, which would inevitably have to be paid off through tax increases.

Fiscal stimulus packages should be based upon tax cuts. This would stimulate work, investment and enterprise.

An increase in spending is both wasteful, and potentially damaging. The IEA cites the US as an example, where long-term unemployment has increased between 1% and 2% due to more unemployment entitlements.

The IEA warns of a wider economic crisis of government debt, stretching beyond the €urozone - the US is equally at risk as EU member states.

The debt crisis involves both explicit borrowing, and implicit liabilities, meaning that public spending reform, together with tax cuts are required.

The report from the IEA offers some solutions:

Cut marginal tax rates to improve economic activity.

Maintain low interest rates.

More reform and limitations to long-term liabilities

Monetary and fiscal policy should be separated by governments, so that countries are not liable for one another's borrowing.

The IEA's Director General, Mark Littlewood, has said in response to the report:

“We must resist the calls of those who say that one last, big spending push could get the economy back to meaningful growth. The opposite is true. Many Western economies might well be tipping back towards recession partly because of these giant fiscal packages that were enacted in 2009, and the coalition government must resist calls for any Plan B that involves more government borrowing and spending. The government must be firm on deficit reduction – in fact it should go a lot further – and should look to robust supply-side reform to boost growth.”

“Unfunded promises have been made by Western governments looking to garner votes. This is a problem not just in the Eurozone but in the US too. These long-term liabilities relating to state pension and health obligations must be tackled urgently.Recently we have seen the coalition government blink in the face of public sector pensions reform. A more unflinching resolve is needed if the UK’s underlying fiscal issues are to be prevented from turning into a crisis.”